SXYAY - How Canada's Materials Space Is Faring Amid China's Economic Challenges

2023-09-30 01:00:00 ET

Summary

• The impact of China's slowdown on the materials space.
• Why some materials players may not be as exposed to cyclical plays.
• How to play Canada's materials sector.

Economic weakness in China has been creating challenges for Canada’s materials space. Evan Chen, Associate for Portfolio Research at TD Asset Management, discusses the impact on the sector and why some companies may be better positioned than others to absorb economic volatility.

Transcript

Anthony Okolie: Economic weakness in China has been a headwind for the materials space. But our guest today says that some companies in the sector that you may not think of are better poised to face the challenge than others. Joining us now to discuss is Evan Chen, associate for portfolio research at TD Asset Management. Evan, welcome to Moneytalk Live, your first show.

Evan Chen: Thank you. You know, copper is up today. It's a good day to come on. Picked a good day.

Anthony Okolie: Perfect day to come on. So for our viewers who may not be aware, what makes up the materials space? Let's start with - let's start there.

Evan Chen: Yeah, so what is a materials company? Well, you know, it's farthest upstream in the value chain for a lot of different things, I guess. So this building that we're in has steel beams. That's iron ore. It's met coal.

This chair that we're sitting on has plastics, so that's a commodity chemical companies. A cabinet in your home has wood, so that's paper and forestry. So these material companies are very cyclical and commodity-driven.

A lot of them have - you know, they don't have full control over their destiny because they have no pricing power. So if we look at the index, MSCI All Country World Index, about 50-ish percent is commodity-driven.

So that's 30% in mining, 20% in commodity chemicals, and, you know, commodity chemicals is right there in the name, it's a commodity. So you don't have any pricing power. But what I want to talk about today is the other companies in the index that may not be commodity driven and may not be as cyclical. So, so far in the year, materials hasn't done too well, and that's because of some weakness in China and rising rates.

Anthony Okolie: So let's talk about China because we know that China is a major consumer of commodities. How has their current economic weakness impacted this space?

Evan Chen: Yeah, so, you know, a really good rule of thumb is China consumes about 50% of the world's metals. So you can imagine that's a pretty big impact on everything that goes on. So the major ones would be copper, iron ore, aluminum.

So for instance, for copper if the property market in China is not doing too well, then there's less need for copper wiring, copper pipes. In white goods, such as refrigerators, AC units, those all require copper, and if there's less economic activity, then there's less need for it. The price goes down, and that hurts the sector as a whole.

Anthony Okolie: OK, now you also said that not all the materials space is so exposed to cyclical trends though. Can you expand on that for us?

Evan Chen: Yeah, so there are some really great companies in the materials sector that I wouldn't say are overlooked, but people don't think about when you say materials. So the biggest one would be Linde ( LIN ). It's $180 billion, the biggest name in the space, and it's for good reason. So it's an industrial gas company.

And you may be wondering, what is an industrial gas? Well, it goes into everything, just like the other materials we were talking about earlier.

Anthony Okolie: So it's a pretty important company?

Evan Chen: For sure. So these TV screens that are behind us, they have gas to make the flat screens. In the supermarket, you have industrial gases to make your food fresher, in fridges, wine making even, like I could go on and on.

Anthony Okolie: OK, now another stock that you highlight is Sika ( SXYAY ). What can you tell us about this name?

Evan Chen: Yeah, so Sika is a construction chemical company, and it's one of the largest, 15% of the market. And what they do is they sell chemicals for construction sites. So this can be a lot of things, admixtures so it affects concrete and different properties so it make it stronger and make it look better.

They sell adhesives, so sticking a window together or sticking plastics together. Also, they sell waterproofing, so if you have a roof and you want to make it waterproof, then they sell that. So where I think it's less cyclical is because their products are better than the competition.

What does this mean? So if you're on a construction site and maybe it takes you four people two hours to do something. So let's say applying adhesives to a roofing solution, you might need two applications of whatever chemical you have and you need to hold it for two hours.

With a Sika product you could use two people and it would be done in one hour, and this is just because they spend more in R&D. So because they're so big, they can spread that R&D across a wide base, and then start cross-selling other products into different businesses.

So instead of being linked to commodity prices, like oil, Sika is more levered to infrastructure - infrastructure, global construction, and all of that goes around that, you know, we're seeing.

Anthony Okolie: OK, so you talked about some of the benefits of some of these companies. What about the risks to some of these companies? Why don't you start with Sika?

Evan Chen: Yeah, for Sika, it's definitely just construction volumes and lower infrastructure spending. So what we're seeing in the US is some - housing has been strong. If that slows, that's a risk. And in the EU, we're seeing some risks there to construction.

Housing is down 20-30% in various regions. China is also slowing. We talked about the property market in the beginning. So all of those are risks to Sika, but I think longer term, the business is very sound and will continue to grow.

Anthony Okolie: OK talk about Linde. What are some of the risks you see there?

Evan Chen: Yeah so on Linde, I want to touch on some of the strengths first. So Linde, industrial gases company, what they do is they place facilities onto their customer sites. And these are necessary for their customers' operations. And they're underpinned by long-term contracts.

These contracts have minimum spending agreements plus a built-in cost escalator. So you have really good visibility on the long-term earnings of Linde as well. The biggest risk to them would be that these customers go out of business. But it's going to be the last bill that you pay, really, in someone's bill payments because you need it to run your facility.

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